In 1972, a 29-year old electrical engineer named Nolan Bushnell founded Atari, and launched the video game revolution with the creation of Pong, the first arcade video game. He sold Atari in 1976 for $28 million and used the money to start a revolutionary new restaurant for kids and their families: he called it Chuck E. Cheese.

Today, the 68-year old entrepreneur-extraordinaire is back with uWink, a high-tech restaurant concept whose first location opened in Woodland Hills, California a few weeks ago. The restaurant features touch-screen computer monitors at each table for automated ordering, and innovative “social video games.” uWink has received strong initial reviews in the media, and plans to open up its franchising program before the end of the year. The restaurant market is highly competitive, but we believe that uWink has several strengths that will make it stand out from the pack. According to analyst Eric Wold of Merriman Curhan Ford Co., uWink “will bring something to consumers they can’t get anywhere else. The tabletop terminals can be remotely managed—unlike arcade games that break down—and the video meal-ordering will allow the company to save on labor costs for servers.” Below are some of the reasons that we think investors should be bullish on uWink.

Tapping New Markets

While he is proud of his work with Chuck E. Cheese, Bushnell wonders whether the restaurants have aged well. In a recent article in the Dallas Morning News, he expressed concern that “Chuck E. Cheese’s should be an innovative entertainment place…it’s still animals, attractions, the ball crawl. I don’t see a lot of innovation or change. I think it’s gotten a little stagnant…I envisioned people having fun together. That’s not the Chuck E. Cheese experience.” With uWink, Bushnell hopes to make gaming a social experience about people interacting. To that end, he has developed a list of nine “Rules for Social Gaming:”

1. The game must increase or stimulate conversation not stifle it.
2. The games must cross gender and age. Can Grandpa and his 8 year old daughter play and have fun? If not, then it isn’t a social game.
3. The rules of the game need to be immediately perceived.
4. Games must “fail soft.” The worst player in the room must not be made to feel stupid. (Losers have a score of 89 — winners have a score of 99.)
5. The game controller must be as easy to use as a fork.
6. The intensity of the game can not override the social atmosphere – NO GAME ZOMBIES.
7. In longer games there must be breaks for food, drink ordering or non game activities.
8. Games must be “classy” or funny. Not coarse or vulgar.
9. Construct the game so that something in the game can be learned, so that next time their score improves.

Bushnell envisions a restaurant where video games are a catalyst for social interaction, not the obsession of greasy-haired adolescent outcasts. In an interview with San Jose Mercury News, Bushnell talked about the opportunity to use social games to bring non-gamers into the fold:
“In the early eighties, video games got violent and complex, and so now we’re stuck with a marketplace in which there’s about 15 million gamers in the United State out of 300 million. That says there are 285 million non-game players…I think games are good for everybody and I want to bring that back.”

In addition, uWink’s games are only going to get better with time. According to Bushnell, the company is going to wait to release 2-3 games until there are 50-100 uWink stores. These games will be linked to the other restaurants and players will be able to compete against diners throughout the country. This should provide “an interesting social effect” according to Bushnell.

Franchising

We strongly believe that uWink is uniquely well-positioned to succeed in the franchising business. uWink owns all of its own technology, and the programs are not available anywhere else. A look through a recent issue of Entrepreneur Magazine shows advertisements for numerous little-known food franchises: Salad Creations, Little Scoops, and Beef O’Brady’s, to name a few. As it is probably apparent, very few franchisers offer entrepreneurs a unique product. Many would-be restaurateurs will be better off opening their own salad bar than forking over a hefty chunk of their sales to a large company.

uWink spent over ten million dollars developing its technology and if the concept catches on it will be difficult for competitors to make inroads. Franchisees will also be comfortable tying their fortunes to a restaurant created by the founder of Chuck E. Cheese and the man MIT has called “the father of electronic gaming.” Because uWink’s technology is so unique, franchisees with an understanding of the technology’s potential and immediate benefits will have no choice but to franchise through uWink.

Franchising is inherently an excellent business model as franchisers are able to pass on operating risks to individual store-owners. In addition, rather than paying a store manager an hourly wage with no incentive to succeed, store owners have an extremely large incentive to succeed – earning a profitable return on their investment. The franchise model will also allow the company to grow without large infusions of additional capital because the company won’t need to purchase the real estate, store supplies, etc. and the technology costs are likely stalled until the concept is more proven. As such the company will be able to preserve its balance sheet and minimize future dilution avoiding problems that often face companies with interesting technologies.

Franchising is clearly a highly lucrative business. Chuck E. Cheeses (CEC), for example, has produced gross margins consistently above 55% for the last five years, returns on equity in the 20% range, and operating margins of roughly 17%.

High Quality Management

While Nolan Bushnell’s track-record speaks for itself, there are very few publicly traded companies with market caps below $500 million, let alone $25 million, which boast a management roster as impressive as uWink’s. In addition, management is not in this company for the trade as there have been no insider sales following the run-up from 30 cents per share to $1.80 per share during the last few months. When we spoke with a representative at the company they candidly replied, “this is not a story stock.”

Nolan Bushnell, Founder and CEO

Mr. Bushnell founded and was CEO of Atari Corporation, a manufacturer of video games, from 1971 to 1978. He grew the Company to more than $800 million in sales before his departure. He founded and served as CEO of Chuck E. Cheese’s Pizza Time Theater, a restaurant chain featuring electronic entertainment, from 1977 to 1983, and grew that company to more than $350 million in sales. From 1978 to 1996, Mr. Bushnell served as the sole proprietor of Catalyst Technologies, a source of technical advice and venture capital for Silicon Valley entrepreneurs. He served as Chairman for several Catalyst companies such as ETAK, Androbot, ByVideo, Magnum Microwave, Axlon and Octus.

John Kaufman, Director of Restaurant Operations

Mr. Kaufman’s extensive restaurant experience began in Mammoth Lakes, California, where he built and opened three restaurants. In 1986 he joined California Pizza Kitchen, which at the time consisted of a single restaurant, and helped the owners build CPK into one of the country’s leading restaurant chains with more than 68 locations. He eventually supervised more than 3,000 employees including 250 managers, 12 area supervisors and two regional vice-presidents of operations. In 1995 after completing a four-month consulting project for Rosti, Mr. Kaufman was brought in as COO. He worked closely to develop a very young management team and created an operating system, company structure and culture that achieved profitability. In 1996 he was recruited by Koo Koo Roo and brought in as President and Chief Operating Officer. In less than two years the team turned the company from cash negative to cash positive by focusing resources on the core brand, increasing performance, controlling costs, and improving customer service. In the process, Mr. Kaufman also designed and built new prototype restaurants that reduced capital requirements by 40 percent and substantially increased operational efficiency.

Peter Wilkniss, CFO

Mr. Wilkniss has over 12 years experience in operational and financial leadership in entrepreneurial technology-driven arenas. His areas of expertise include corporate finance and financial reporting, M&A, business development and strategic planning. Mr. Wilkniss was formerly Managing Director and CFO for a subsidiary of Jefferies Group, Inc. (NYSE: JEF) and a corporate attorney at Wachtell, Lipton, Rosen & Katz. He has also held senior management roles in early-stage technology and e-commerce companies. Mr. Wilkniss holds an MBA from Columbia Business School and a JD from Columbia Law School (with highest honors). He received his BA from the University of Virginia.

Paul Dumais, Chief Technology Officer

Paul Dumais is a web pioneer and inventor. He was formerly Senior Software Engineer and Project Leader at Apple Computer, where, in their Interactive Marketing Group, he oversaw Apple’s entire webcasting efforts and Web site development. Paul’s inventive solutions led to the first world-wide live webcast for the Grammy Awards. He has over 19 years as a Software Developer and Systems Architect, specializing in the integration of technology and entertainment. Mr. Dumais has played leadership and development roles in film distribution rights management and sales, content management systems, online communities, interactive TV, and multiplayer online gaming. As Director of Digital Operations at Intertainer, Mr. Dumais was responsible for network engineering and systems integration and designed the company’s platform for Video-on-Demand over IP networks. As the founder of Moose Factory, Paul has developed technology solutions for Comedy Central, Nike, Endeavor Agency, Filmbazaar, LegalZoom and Intermix, among others.

Valuation

Because uWink is just beginning its operations (first restaurant opened on October 16th), it is difficult to value uWink uses the traditional metrics for several reasons, primarily their emphasis on the rear view mirror. However because of its unique technology, world-class management, and differentiation, we believe that uWink will fetch a multiple substantially higher than its industry peers once it is profitable, much like Cheesecake Factory (CAKE), Chipotle (CMG), Panera (PNRA) and other unique restaurant concepts. The automated ordering and possibility of selling advertising on the terminals could also lead to margins substantially higher than other food service companies. With a market cap of less than $25 million and highly innovative technology, the downside risk appears to be insignificant compared to the tremendous upside potential. Therefore, we are initiating coverage of uWink with a rating of speculative buy.

Disclosure: Zac Bissonnette has a long position in UWNK. Kevin Kelly has no position. Viisit Kevin's site at valueblogger.com. Zac's site is deepvalues.blogspot.com.

About the author:

Zac Bissonnette

Zac Bissonnette lives on Cape Cod, and specializes in finding stocks trading at a discount to their liquidation value, but occasionally ventures off into GARP stocks.

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